Job Order Cost System

job order costing system is used in situations where many different products are produced each period. For example clothing factory would typically made many different types of jeans for both men and women during a month. In a job order costing system, costs are traced to the jobs and then the costs of the job are divided by the number of units in the job to arrive at an average cost per unit. Job order costing system is also extensively used in service industries. Hospitals, law firms, movie studios, accounting firms, advertising agencies and repair shops all use a variety of job order costing system to accumulate costs for accounting and billing purposes. The details here deal with a manufacturing firm, the same concept and procedures are used by many service organizations. The record keeping and cost assignment problems are more complex in a job order costing system when a company sells many different products and services than when it has only a single product or service. Since the products are different, the costs are typically different. Consequently, cost records must be maintained for each distinct product or job. For example an attorney in a large criminal law practice would ordinarily keep separate records of the costs of advising and defending each of her clients. And a clothing factory would keep separate track of the costs of filling orders for particular styles, sizes, and colors of jeans. A job order costing system requires more effort than a process costing system. Companies classify manufacturing costs into three broad categories:(1) direct materials, (2) direct labour, (3)manufacturing overhead. As we study the operation of a job costing system, we will see how each of these three types of costs is recorded and accumulated.

The job order cost system is used when products are made based on specific customer orders. Each product produced is considered a job. Costs are tracked by job. Services rendered can also be considered a job. For example, service companies consider the creation of a financial plan by a certified financial planner, or of an estate plan by an attorney, unique jobs. The job order cost system must capture and track by job the costs of producing each job, which includes materials, labor, and overhead in a manufacturing environment. To track data, the following documents are used: Job cost sheet. This is used to track the job number; customer information; job information (date started, completed, and shipped); individual cost information for materials used, labor, and overhead; and a total job cost summary. Materials requisition form. To assure that materials costs are properly allocated to jobs in process, a materials requisition form It is usually completed as materials are taken from the raw materials inventory and added to work-in-process.

Time ticket. Labor costs are allocated to work-in-process inventory based on the completion of time tickets identifying what job a worker spent time on.

Predetermined overhead rate

Factory overhead costs are allocated to jobs in process using a predetermined overhead rate. The predetermined overhead rate is determined by estimating (during the budget process) total factory overhead costs and dividing these total costs by direct labor hours or direct labor dollars. For example, assume a company using direct labor dollars for the allocation of overhead estimated its total overhead costs to be $300,000 and total direct labor dollars to be $250,000. The company's predetermined overhead rate for allocating overhead to jobs in process is 120% of direct labor dollars, and is calculated as follows: If direct labor costs are $20,000 for the month, overhead of $24,000 ($20,000 120%) would be allocated to work-in-process inventory. Factory overhead would be allocated to individual jobs based on the portion of the $20,000 direct labor cost that is assigned to each job. If job number 45 had $9,000 in direct labor cost for the month, factory overhead of $10,800 ($9,000 120%) would also be allocated to the job. Once a job is completed, the total costs assigned to the job are transferred from work-inprocess inventory to finished goods inventory. Once the job is sold and delivered, the job costs are transferred from finished goods inventory to cost of goods sold.

Job Order Costing - The Flow of Cost:

The flow of costs in job order costing system, we shall consider a single month's activity for a company, a producer of product A and product B. The company has two jobs in process during April, the first month of its fiscal year. Job 1, of 1000 units of product A was started in march. By the end of march, $30,000 in manufacturing costs had been recorded for the job 1. Job 2 an order for 10,000 units of product B was started in April.

The Purchase and Issue of Materials:

On April 1, the company had $7,000 in raw materials on hand. During the month, the company purchased an additional $60,000 in raw materials. The purchase is recorded in

journal entry (1) below: (1) Raw Materials Accounts Payable 60,000 60,000 Dr. Cr.

Raw materials is an asset account. Thus, when raw materials are purchased, they are initially recorded as an asset--not as an expense.

Issue of Direct and Indirect Materials:

During April, $52,000 in raw materials were requisitioned from the storeroom for use in production. These raw materials include both direct and indirect materials. Entry (2) records issuing the materials to the production department. (2) Work in Process Manufacturing Overhead Raw Materials 50,000 2,000 52,000 Dr. Dr. Cr.

The materials charged to work in process (WIP) represents direct materials for specific jobs. As these materials are entered into the work in process account, they are also recorded on the appropriate job cost sheets. This point is illustrated in Exhibit 1.1 where $28,000 of the $50,000 in direct materials is charged to Job 1 cost sheet and the remaining $22,000 is charged to job 2 cost sheet. (In this example, all data are presented in summary form and the job cost sheet is abbreviated.) The $2,000 charged to manufacturing overhead in entry (2) represents indirect materials used in production during April. Observe that the manufacturing overhead account is separate from work in process account. The purpose of the manufacturing overhead account is to accumulate all manufacturing overhead costs they are as they are incurred during a period. Before leaving Exhibit 1.1 we need to point out one additional thing. Notice from the exhibit that the job cost sheet for job 1 contains a beginning balance of $30,000. We stated earlier that this balance represents the cost of work done during march that has been carried forward to April. Also note that work in process account contains the same $30,000 balance. The reason the $30,000 appears in both places is that the work in process account is a control account and the job cost sheets form a subsidiary ledger. Thus, the work in process account contains a summarized total of all costs appearing on the individual job cost sheet for all jobs in process at any given point in time. (Since the

company had only job 1 in process at the beginning of April, job 1's $30,000 balance on that date is equal to the balance in the work in process account.

Exhibit 1.1 Issue of Direct Materials Only:

Some times the materials drawn from the raw materials inventory account are all direct materials. I this case, the entry to record the issue of the materials into production would be as follows: Work in proces s Raw materials XX X XXX

Dr.

Cr.

Labor Cost:
As work is performed each day in various departments of the company, employee time tickets are filled out by workers, collected, and forward to the accounting department. In the accounting department, wages are computed and the resulting costs are classified as either direct or indirect labor. This costing and classification for April resulted in the following summary entry: (3) Wor k in proc ess Man ufac turin g over head Salaries and wages payable

60,000

Dr.

15,000

Dr.

75,000

Cr.

Only direct labor is added to the work in process account. In this example, direct labor is $60,000 for April. At the same time the direct labor costs are added to work in process, they are also added to the individual job cost sheets, as shown in the Exhibit 1.2. During April, $40,000 of

direct labor cost was charged to job 1 and the remaining $20,000 was charged to job 2. The labor cost charged to manufacturing overhead represent the indirect costs of the period, such as supervision, janitorial work, and maintenance.

Exhibit 1.2

Manufacturing Overhead Costs:

All costs of operating the factory other than direct materials and direct labor are classified as manufacturing overhead costs. These costs are entered directly into the manufacturing overhead account as they are incurred. To illustrate, assume that the company incurred the following general factory costs during April: Utilities (heat, water, and power) Rent on factory equipment Miscellaneous factory costs $21,000 16,000 3,000 -------Total $40,000 ====== The following entry records the incurrence of these costs: (4) Manufacturing overhead Accounts Payable 40,000 40,000 Dr. Cr.

In addition, let us assume that during April, the company recognized $13,000 in accrued property taxes and that $7,000 in prepaid insurance expired on factory buildings and equipment. The following entry records these items: (5) Man ufac turin g over head

20,000

Dr.

Property taxes payable Prepaid insurance

13,000 7,000

Cr. Cr.

Finally let us assume that the company recognize $18,000 in depreciation on factory equipment during April. The following entry records the accrual of this depreciation: (6) Manuf acturin g overhe ad Accumulated Depreciation

18,000

Dr.

18,000

Cr.

In short, all manufacturing overhead costs are recorded directly into the manufacturing overhead account as they are incurred day by day through a period. It is important to understand that manufacturing overhead is a control account for many--perhaps thousands--of subsidiary accounts such as indirect materials, indirect labor, factory utilities, and so forth. As the manufacturing overhead account is debited for costs during a period the various subsidiary accounts are also debited. In this example we omit the entries to the subsidiary accounts for the sake of brevity.

Calculation of Predetermined Overhead Rate and Application of Manufacturing Overhead to Work in Process (WIP):
Since actual manufacturing costs are charged to the manufacturing overhead control account rather than work in process account. How are manufacturing costs assigned to work in process? The answer is, by means of the predetermined overhead rate. A predetermined overhead rate is established at the beginning of each year. The predetermined overhead rate is calculated by dividing the estimated total manufacturing overhead cost for the year by the estimated total units in the allocation base (measured in machine hours, direct labor hours, or some other base). This rate is then used to apply overhead costs to jobs. To illustrate assume that the company has used machine hours to compute predetermined overhead rate and that this rate is $6 per machine hour. Also assume that during April, 10,000 machine hours were worked on Job 1 and 5,000 machine hours were worked on Job 2 (a total of 15,000 machine hours). Thus, $90,000 in overhead cost (15,000 machine hours $6 per machine hour = $90,000) would be applied to work in process. The following entry records the application of manufacturing overhead to work in process: (7)

Work in process Manufacturing overhead

90,00 0 90,000

Dr. Cr.

Exhibit 1.3
The actual overhead cost in the manufacturing overhead account in Exhibit 1.3 are the costs that were added to the account in entries (2)--(6). Observe that the incurrence of these actual overhead costs and the application of overhead to work in process represents two separate and entirely distinct processes.

The Concept of Clearing Account:

The manufacturing overhead account operates as a clearing account. As we have noted, actual factory overhead costs are debited to the accounts as they are incurred day by day through the year. A certain intervals during the year, usually when a job is completed, overhead cost is applied to the job by means of the predetermined overhead rate, and work in process is debited and manufacturing overhead is credited. This sequence of events is illustrated below: Manufacturing Overhead (a clearing account) Actual overhead costs are charged to this account as they are incurred throughout the period. Overhead is applied to work in process using the predetermined overhead rate.

As we emphasized earlier, the predetermined overhead rate is based on estimates of what overhead costs are expected to be, and it is established before the year begins. As a result, the overhead cost applied during a year will almost certainly turn out to be more or less than the overhead cost that is actually incurred. For example, notice from Exibit 1.3 that the company's actual overhead costs for the period are $5,000 greater than the overhead cost that has been applied to work in process (WIP), resulting in a $5,000 debit balance in the manufacturing overhead account. This debit balance in manufacturing overhead account is called under-applied overhead. Any credit balance in manufacturing overhead account is called over-applied overhead. Any balance in the manufacturing overhead account (under or over-applied overhead) is treated in one of the following ways:

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Closed out to cost of goods sold Allocated between work in process, finished goods, and cost of goods sold in proportion to the overhead applied during the current period in the ending balance of these accounts. These two methods are illustrated on Disposition of under or overapplied overhead Balances page. For the moment, we can conclude by nothing from Exhibit 1.3 that the cost of a completed job consists of the actual materials cost of the job, the actual labor cost of the job, and the overhead cost applied to the job. Pay particular attention to the following subtle but important point: Actual overhead costs are not charged to jobs; actual overhead costs do not appear on the job cost sheet nor do they appear in the work in process account. Only the applied overhead cost, based on the predetermined overhead rate, appear on the job cost sheet and in the work in process account. Study this point carefully.

Non-manufacturing Costs:
In addition to manufacturing costs, companies also incur marketing and selling costs. These costs should be treated as period expenses and charged directly to the income statement and therefore should not go into the the manufacturing overhead account. To illustrate the correct treatment of non-manufacturing costs, assume that the company (in this example) incurred $30,000 in selling and administrative salary costs during a months, the following entry records these salaries. (8) Salar ies expe nse Salaries and wages payable 30,00 0 30,000

Dr

Cr

Depreciation on factory equipment is debited to manufacturing overhead account but depreciation on office equipment is considered a period expense and is not included in manufacturing overhead. Assume that depreciation of office equipment during the month was $7,000. The entry is as follows. (9) D ep re ci 7,00 0 Dr

ati on ex pe ns e Accumulated depreciation 7,000 Cr

Finally assume that advertising was $42,000 and that other selling and administrative expenses during the month was $8,000. The following journal entry records these items: (10) Adv ertis ing exp ense s Oth er selli ng and adm inist rativ e exp ense Accounts payable

42,0 00

Dr.

8,00 0

Dr.

50,000

Cr.

Since the amounts in entries above all go directly into expense accounts, they will have no effect on the costing of the company's production for the month. The same will be true of any other selling and administrative expenses incurred during the month including sales commission, depreciation on sales equipment, rent on office facilities, insurance on office facilities, and related costs.

Cost of Goods Manufactured (COGM):

When a job has been completed, the finished out put is transferred from the production department to the finished goods warehouse. By this time, the accounting department will have charged the job with direct materials and direct labor cost and manufacturing

overhead will have been applied using the predetermined overhead rate. A transfer of costs is made within the costing system that parallels the physical transfer of the goods to the finished goods warehouse. The costs of the completed jobs are transferred out of the work in process(WIP) account and into the finished goods account. The sum of all amounts transferred between these two accounts represents the cost of goods manufactured for the period. Let us assume that the job 1 was completed during the period. The following entry transfers the cost of job 1 from work in process (WIP) to finished goods. (11) Fini shed goo ds Work in process

158,000

Dr.

158,000

Cr

The $158,000 represents the completed cost of job 1, as shown on the job cost sheet in Exhibit 1.3. Since job 1 was the only job completed during April, the $158,000 also represents the cost of goods manufactured for the month. The job 2 was not completed by month-end, so its cost will remain in the work in process (WIP) account and carry over to the next month. If a balance sheet is prepared at the end of April, the cost accumulated thus far on the job 2 will appear as "work in process inventory" in the assets section.

Cost of Goods Sold (COGS):

As units in the finishd goods are shipped to the customers, their costs are transferred from the finished goods account into the cost of goods sold account. If complete job is shipped, as in the case where a job has been done to a customer's specification then it is a simple matter to transfer the entire cost appearing on the job cost sheet into the cost of goods sold account. In most cases, only a portion of the units involved in a particular job will be immediately sold. In these situations the unit cost must be used to determine how much product cost should be removed from finished goods and charged to cost of goods sold. Assume that the company has completed 1000 units and 750 out of 1000 units have been shipped to customers for a price of $225,000. The unit product cost is $158. Following journal entries would record the sales (all sales are on account). (12) Acco unts receiv 225,000 Dr.

able Sales 225,000 (13) Cost of goods sold Finished goods ($158 750units = $118,500*) 118,5000 * 118,5000 Dr. Cr. Cr.

Advantages & Disadvantages of Job Order Costing :

Costing is an accounting technique used to determine the exact expenses for materials, labor and overhead incurred in operations. Job order costing records the actual materials and labor expenses for specific jobs, and assigns overhead to jobs at a pre-determined rate. Process costing applies costs to departments based on the average number of units produced per day. Job order and process costing have unique advantages and disadvantages that make them best suited for specific situations.

Assigning Costs
One advantage of job order costing is that it allows managers to calculate the profit earned on individual jobs, helping them to better ascertain whether specific jobs are desirable to pursue in the future. This is best for businesses that do highly custom work, such as construction contractors and consultants. An advantage of process costing is that it allows managers to get detailed information on the production statistics of individual departments or workgroups. This is best suited for continuous manufacturing settings, such as factories and utility companies.

Record Keeping
A disadvantage of job order costing is that employees are required to track all materials and labor used during the job. Process costing simplifies record keeping by relying on statistical calculations rather than actual inputs. As an example, consider a construction contractor using a job order costing system. The contractor has to keep track of all the wood, nails, screws, electrical fixtures, paint and other materials used on the job, as well as tracking workers' lunch breaks and hours worked. In a factory setting, on the other hand, materials are calculated using an average of units produced, and salaries expenses

are often relatively consistent between pay periods.

Reporting
Job order costing gives managers the advantage of being able to keep track of individuals' and teams' performance in terms of cost-control, efficiency and productivity. Process costing, on the other hand, gives managers the advantage of being able to ascertain the same qualities in entire departments and compare performance over time.

Unit Cost Calculation

Job order and process costing are adequate to determine the average cost of each unit produced. According to mdc.edu, the formula for unit cost calculation in a job order costing system is: Unit Cost = Total Job Cost / Number of Units Produced in Job In many cases, such as the construction contractor example, only one unit is technically being produced per jobin this case one deck or one bathroom remodeling. The formula for unit cost calculation in a process cost system is: Unit Cost = Department's Periodic Cost / Number of Units Produced in the Period Unit cost considerations are generally more relevant in situations suited for process costing.